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Rand hit again as S&P downgrades South Africa to ‘junk’

The South African rand, already hit hard by the recent cabinet reshuffle and ousting of former finance minister, Pravin Gordhan, is under pressure again after rating agency, S&P Global, cut the country’s credit rating to ‘junk’ status.

CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.

Source: Bloomberg

The downgrade

South Africa’s foreign credit rating has been cut to BB+, from BBB-, by S&P Global, moving the country’s foreign currency credit to a sub-investment grade or what is commonly referred to as ‘junk’ status. This is furthered by the agency placing a negative outlook on the foreign sovereign credit worthiness.

Why did it do that?

The S&P has justified its decision with the following statement: ‘The downgrade reflects our view that the divisions in the government led by the African National Congress (ANC) have led to changes in the executive leadership, including the finance minister, which have put policy continuity at risk', obviously referring to president Jacob Zuma’s controversial cabinet shift last week.

The rating agency goes on to say that its negative outlook ‘reflects S&P’s view that political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth outcomes more than S&P currently projects.’

Is there still hope?

Yes, for now. Foreign currency debt, as noted by treasury, accounts for around 10% of South African debt, while 90% of the country’s debt is denominated in local currency, which still carries an investment grade rating. The local currency debt still stands one notch above sub-investment grade after the S&P downgraded the local debt by one notch further.

If the local currency credit rating was to reach ‘junk’ status as well, it would be catastrophic for the country’s liquidity and ability to finance debt, spur much-needed economic growth and, in turn, employment growth. It would be likely that following this scenario, should it occur, South Africa would eventually need a bailout from the International Monetary Fund (IMF).

More to come

Essentially we would need a second rating agency to downgrade the country’s foreign credit rating to ‘junk’ before a range of portfolios are unable to invest in South African foreign currency debt, making it more difficult and expensive for the government to obtain funding for its economic endeavours. That looks like a likely scenario. Fitch Ratings looks set to follow S&P’s lead, having already raised concerns about the political situation in the wake of the cabinet reshuffle. Meanwhile, the third major ratings agency, Moody’s Investors Service has put South Africa on a downgrade review following the recent mass change in leadership.

And the markets?

The rand has been at the forefront of declines, having weakened most days since a switch at the helm of the treasury was first speculated. The weakness in the rand after the S&P announcement wasn’t quite as pronounced as expected, which suggests the downgrade was not necessarily a big surprise following last week’s events.

The trend bias does however suggest further weakness in the currency with R14.50 to the dollar a likely short-term target. South African bond yields have soared, with the government benchmark R186 bond to be bid at more than 9%.

South African-listed banks are set to re-rate in lieu of a downgrade to come. When a country’s sovereign credit rating is lowered, so does the respective banks’ ratings in weeks to come.

Interestingly, just over 60% of earnings on the Johannesburg Stock Exchange’s Top 40 index are realised outside South Africa, meaning the local bourse overall might be able to mitigate losses from the financial and retail (to a lesser degree) sectors.

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CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.